The budget compromise reached by Gov. Arnold Schwarzenegger and the Legislature calls for the state to appropriate $1 billion from the State Fund, and the only realistic way of hitting that goal is selling off its most profitable lines – which have been subsidizing the rates.

The State Fund’s constitutional role is the insurer of last resort for tens of thousands of businesses such as construction companies and other businesses with a high risk of worker injury. Over the years, the State Fund – which is run like a private company by a government-appointed board – has expanded to offer market rate coverage for lower-risk companies, such as advertising agencies and other professional service firms.

The planned sale is significant because it would likely drive up premiums for the thousands of Los Angeles County employers in high-risk categories because the lower-risk lines subsidize the riskier policies.

But the sale plan, little noticed amid the larger state budget battle, faces a hurdle. The 11-member State Fund board – nine of whom were appointed by Schwarzenegger – has voted to oppose the sale of its business assets, saying it would not only harm the solvency of the State Fund but would also hurt the state’s economy. Meanwhile, the governor’s administration contends the budget provision will be enforced despite the board’s opposition.

But even if the administration can force a sale, it’s not at all clear whether other carriers would step forward to buy the customer portfolio and at what price.

Business groups, struggling with recession, fear their members will be hit with premium hikes without the possibility of buying affordable policies elsewhere. They’re concerned about a return to the situation of six years ago, when rates doubled and even tripled, forcing companies to lay off workers or leave the state.

“Many small businesses in high hazard industries have no other options than to go with State Fund,” said Scott Hauge, a Bay Area insurance broker who heads Small Business California, an advocacy group that has been one of Schwarzenegger’s strongest allies. “If the better business in State Fund is sold off, the remaining businesses would have their rates increase.”

Hauge said this couldn’t come at a worse time. The entire workers’ compensation insurance market appears headed for an extended period of rate hikes and turmoil as medical and other claim costs have outstripped premium revenue. Rate increases at the State Fund would only exacerbate the situation.

That’s the concern at one L.A. tree-trimming company that buys its workers’ compensation insurance from the State Fund.

“I’m very concerned that rates would go up,” said Paul Pondella, president of Tree King Tree Service Inc., which has insured its 18 employees by State Fund since the mid-1990s.

Pondella said few if any private carriers would take his company, given the high risk of injury in the tree-trimming business. “We can’t raise rates too much, because then everyone would go to their gardeners to get their trees trimmed. So we’d have to cut employees if the rates really shoot up.”

For roofing companies, a spike in the State Fund’s rates could force smaller operators to skirt the law.

“This will hit hardest those of us who are playing by the rules,” said Dave Chapman, president of Chapman Coast Roofing in Fullerton who is also president of the Roofing Contractors Association of Southern California.

Chapman said his own company and most other roofing contractors are insured with the State Fund.

“If this State Fund sale happens and rates go up, I guarantee you more roofers will misclassify their employees so that they won’t have to pay the higher premiums,” Chapman said. “The more they raise the rates, the more cheating will go on.”

The concern has also spread to associations that have group policies with the State Fund for their members. The Southern California Builders Association, which has 2,600 member companies stretching from Los Angeles to San Diego, has enrolled several hundred of those members in a group policy with the State Fund.

“If this happens, our members would have to raise their prices to do business,” said John Trocolli, the association’s executive director. “It would be the same problem we faced five or six years ago when rates went so high and the market became so dysfunctional.”

Comp crisis

From 2000 to 2004, more than two dozen insurers dropped their California workers’ comp business and many employers saw their premiums triple in four years. As a result, thousands of employers flocked to the State Fund, which by 2004 swelled to encompass more than 50 percent of all premium dollars in the state.

The State Fund’s board members cited that recent history in their decision to reject the governor’s proposal.

During the 2000-04 period, “State Fund stepped up to fulfill its leadership role as a critical safety net for the market by providing coverage for most of those (distressed) policyholders and prevented a workers’ comp market collapse and the drain on the state’s economy that would have resulted,” according to a statement released by the board after last month’s vote to oppose the sale.

State Fund spokeswoman Gina Simmons said that no sale could go forward without the board’s agreement.

The governor’s administration disputes that. In fact, the Department of Finance plans to hire a “sale side adviser” within 60 days. The adviser will analyze what parts of the State Fund are most suitable to put on the block.

“We are moving forward with this. It was the intent of both the Legislature and the governor and it is now enacted state policy,” said H.D. Palmer, spokesman for the state Department of Finance.

The issue could end up in court, tying up any sale of the State Fund’s book of business for months.

And even if parts of the State Fund do go on the block, industry watchers say there’s no guarantee that private carriers would make sufficient bids.

“The portfolio is not big enough or profitable enough to get $1 billion from a sale,” said Dale Debber, publisher of the Workers’ Comp Executive, an industry trade publication in Sacramento.

Debber said that the State Fund’s loss ratio is 1.62, meaning that for every premium dollar the State Fund takes in, it pays out $1.62 in claims costs and overhead. Even including the profitable lines, Debber said that the State Fund stays afloat only by drawing on income earned on its reserves.

At the peak of the crisis in 2003-04, the average workers’ comp premium statewide was $6.45 per $100 of payroll, then fell back progressively until 2008, when it hit $2.25.

The State Fund raised its basic premium rates 9 percent as of Jan. 1 and filed for an additional 15 percent rate increase as of July 1.

It’s uncertain how much the State Fund would have to raise its rates for high-risk policies if it were forced to sell lower-risk lines. That will depend on what blocks are sold and in what combinations.

In the last few months, as medical costs have risen and revenue from insurance premiums have flattened or declined, several carriers have pulled back from the California market, including Employers Direct of Agoura Hills, which announced in late June that as of Aug. 1, it would cease writing new policies in the state.

The fear that the State Fund could become insolvent if its most profitable parts are sold off may affect how other insurers view the marketplace. Today’s situation, with costs outstripping premiums, could lead to more insurers halting business in California as they did during the last workers comp crisis.